Patience of US legislators regarding the value of the Yuan has finally given out. Last Friday, Congress jumped into the fray after exceptionally harsh statements from Treasury Secretary Tim Geithner, who up until now had always preached diplomacy. Here is a brief sequence of events.
Patience Runs Out
MarketWatch reports Patience runs out on quiet diplomacy on China currency.
Sept. 15, 2010
Patience appears to have run out in Washington for the standard White House approach that favors quiet diplomacy for dealing with China over the dispute over the value of its currency.
In testimony to the House Ways and Means Committee, a wide array of experts said that quiet diplomacy has essentially been a failure. The only debate at the hearing was what new approach should be tried.
Geithner Enters the Battle
One day later Geithner calls for faster yuan appreciation
Sept. 16, 2010
“China needs to allow significant, sustained appreciation over time to correct this undervaluation and allow the exchange rate to fully reflect market forces,” Geithner said in testimony prepared for the Senate Banking Committee. Geithner will also talk about the yuan with the House Ways and Means Committee this afternoon.
“It is past time for China to move,” Geithner said.
An undervalued yuan has helped China to boost exports and encouraged U.S. companies to outsource manufacturing to China from the U.S., Geithner said. He added that the yuan is held at a undervalued level by “heavy intervention” even as Chinese officials have pledged to allow the yuan’s value to be guided more by market forces.
China Rebuffs Geithner
Responding to Geithner, China says it won’t repeat Japan’s mistake
Sept. 20, 2010
China pledged not to repeat Japan’s mistake and allow its currency to rise in response to foreign pressure, countering criticism from U.S. lawmakers that the yuan is undervalued amid a growing cross-Pacific row over Beijing’s currency regime.
“China will not go down the path that Japan did and give in to foreign pressure on the yuan’s exchange rate,” Li Daokui, an economist and member of the monetary policy committee of the People’s Bank of China, was cited as saying in a report by the state-run China Daily.
Li’s comments appeared to reference to the 1985 Plaza Accord that resulted in coordinated government intervention in the currency markets to bring down the value of the U.S. dollar amid concerns over a ballooning trade deficits with its most important trading partners.
There’s growing concern in Beijing that the strong-yen agreement doomed Japan’s economy.
Attracted by the appreciating yen, cash flowed into Japan in the late 1980s, resulting in loose monetary conditions that helped fuel a bull market in stocks and real estate. The resulting asset bubble burst in 1990, followed by two decades of economic stagnation in Japan.
“But what has the US done to reduce its trade deficit?” Li said. “The US should pay much more attention to its own problems.”
Congress Risks Trade War
Geithner's sounding off and the rebuke from China were all it took to spur Congress into action.
The Financial Times reports US Congress to attack renminbi valuation
Sept. 23, 2010
Democratic leaders in the House of Representatives will move ahead with a bill allowing the US to retaliate against China for manipulating its currency, a significant escalation of the dispute between Washington and Beijing.
Sander Levin, chairman of the ways and means committee in the House of Representatives, said on Wednesday the bill would be compatible with World Trade Organisation rules.
But in a largely untested area of trade law the measure will evoke opposition from Beijing and could lead to a legal challenge in the WTO. The bill will go to committee on Friday and could be voted on by the full House as early as next week.
“This bill is being advanced in the absence of effective action on a multilateral basis,” Mr Levin said.
Hours later, Wen Jiabao, the Chinese premier, told business leaders in New York that pressure on Beijing was unwarranted.
“The conditions for a major appreciation of the renminbi do not exist,” he said. If the renminbi were suddenly to rise by a large degree against the dollar, “we cannot imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs, and how many migrant workers will return to the countryside... China would suffer major social upheaval”.
Risk of Trade Wars Looms
The Telegraph reports Risk of trade war rises as key US committee backs tariffs on China
The adoption of the measure by the Ways and Means Committee on Friday means it will now be voted on by the House of Representatives on Wednesday.
"China's exchange-rate policy has a major impact on American businesses, and Americans jobs, which is what this is all about," said Sander Levin, a Democrat from Michigan and chairman of the committee.
China's determination to shackle the strength of its currency helped turn the country into the world's manufacturing hub for everything from iPods to T-shirts and, until the recession bit, attracted few critics. But an unemployment rate of 9.6pc in the US, as well as upcoming Congressional elections, is spreading anger across Capitol Hill.
According to the bill's supporters, a properly valued yuan would move jobs back to the US as exports from China become more expensive. The Peterson Institute for International Economics in Washington argues up to 500,000 American jobs could be created.
Not every US company shares the committee's view. Wal-Mart and Citigroup are among companies lobbying against the Bill, fearing it will provoke retaliation in China. If the bill passes next week, the Senate will still need to vote on it.
House Vote Set
Bloomberg reports China Currency Measure Set for Vote in U.S. House
Legislation pressing China to raise the value of its currency is set for a vote in the U.S. House next week, as Republicans joined Democrats in expressing frustration that the yuan is appreciating too slowly.
“We cannot wait any longer to level the playing field for U.S. businesses and protect American manufacturing jobs,” Democratic Leader Steny Hoyer of Maryland said yesterday after the Ways and Means Committee sent the bill to the full House.
The committee adopted the measure by voice vote after the panel’s top Republican, Dave Camp of Michigan, voted with Democrats to back the bill. The full House will vote Sept. 29, said committee Chairman Sander Levin of Michigan, a Democrat.
The measure would let companies petition for higher duties on imports from China to compensate for the effect of a weak currency. President Barack Obama’s administration hasn’t taken a position on the bill, said Natalie Wyeth, a Treasury Department spokeswoman.
The currency dispute “is a proxy for the state of the overall U.S.-China commercial relationship,” William Reinsch, president of the Washington-based National Foreign Trade Council, said Sept. 23 on Bloomberg Television. “I don’t think it will have that big of an impact on the American economy.”
Lawmakers fended off warnings from lobbyists representing companies such as Caterpillar Inc., Wal-Mart Stores Inc. and Citigroup Inc., who said the measure may lead to retaliation against U.S. companies operating in China and curb exports to the country. China may retaliate if the House passes the legislation, said Reinsch, who represents multinational companies such as Caterpillar.
Forty-four Republicans had already signed on as sponsors of the original bill, and with Camp’s support, lobbyists said they expect additional Republicans to vote with Democrats next week.
“Provoking tension with our trading partners doesn’t come without costs, and we should choose our battles carefully,” Stephanie Lester, vice president of the Retail Industry Leaders Association, which represents Wal-Mart, said in a statement. “It makes little sense to enact harmful policies that will spark a bilateral conflict over currency with one of our largest trading partners and fastest growing markets for American exports.”
Impact on Jobs
I certainly disagree with C. Fred Bergsten, director of the Peterson Institute for International Economics in Washington who says "Forcing China to raise the value of its currency may create 500,000 jobs in the U.S."
I do not think it will create any jobs. In fact, I think it will cost jobs. Manufacturing is not going to return to the US just because we pass tariffs on China. Wage differentials are too great. Instead, imports will simply come from some other country and rising prices will hurt sales.
Of course we could pass tariffs on the whole world, but who then buy our stuff? The most likely thing to happen if we pass massive numbers of tariffs is global trade will collapse.
How Might China Respond?
Assuming we do pass a bill and the President signs it, China will respond.
Some might argue this would prompt China to dump treasuries. I find that unlikely. However, China would certainly buy less of them.
Here are a few things to consider.
On June 27, China announced it would buy 20 Boeing 777-800 airplanes for $1.4 billion to be delivered between 2013 to 2015. On August 31, Air China announced it would buy 15 Boeing 787-9 aircraft.
Might not China cancel those orders or give all future orders to Airbus? Might not China decide to put a tariff on US agricultural imports?
There are all kinds of ways China could retaliate without dumping treasuries, and we would not like any of them.
Pray tell what if China shuts off all rare earth exports? Please see Rare Earth Diplomacy: Japan Holds Chinese Boat Captain;China Blocks Rare Earth Exports to Japan;China Holds 4 Japanese on Spy Charges;Captain Set Free for a discussion as to what that would mean to US military.
No-Win Situation for Obama
Anti-China sentiment is at a fever pitch in Congress.
If Congress passes a bill, the president will be in a no-win situation, with either his reelection chances or the economy at huge risk. For example, if the president vetoed a bill he would be attacked from members of both political parties.
If he signed a bill and numerous import tariffs placed, global trade would collapse and the US would soon be back in a deep recession, assuming you believe Good News: The Great Recession is Over.
Regardless, trade wars will make matters much worse. Does anyone remember Smoot-Hawley?
First Things First
We still do not know if the Senate will take up the measure before the election, what the Senate version will look like, whether the president will sign the bill if the measure passes, and whether or not the final version of the bill mandates action instead of noise.
Lots of things can happen. Hopefully cooler heads prevail. One final point: Trade wars like these are hallmarks of deflationary times.
Addendum - Fair Trade or Free Trade?
I was asked "Mish, what if we adopted a 'fair trade' policy where we only traded with countries that meet certain standards. Ie.) they need a EPA equivalent, UI, etc. This would seemingly stimulate jobs here while raising the global standard of living no?"
That may sound good but what constitutes "fair trade? Who gets to define "fair"? Us or them?
Assume for a second that everyone is selling us stuff for far less than its worth. Who is harmed by this, us or them? The overwhelming percentage of the population (everyone but the handful of jobs we would save by tariffs) comes out ahead. How is this not a good thing?
Imagine going into Walmart (NYSE:WMT) and demanding to pay higher prices. They would think you were nuts, and so would I. Go into a small business and demand to pay more and they will probably accommodate you. People shop at Walmart, Target (NYSE:TGT), Kohls (NYSE:KSS), Best Buy (NYSE:BBY) or wherever because they like low prices.
The only people who don't like low prices are those who think (incorrectly) that higher prices will bring back jobs. But they won't.
The irony in this "fair trade" argument is the US is arguably one of the biggest abusers of "fair trade" around, especially on agricultural products. The EU is second.
Even Canada bitches at us regarding agricultural goods and lumber. Year in and year out trade agreements die on US and EU agricultural subsidies.
I maintain the first country that practices free trade regardless of what anyone else does will be a winner.